First-time home buyers see some hurdles lowered as others rise

The slowing in residential real estate hasn't helped with affordability in the entry-level market but  it has slightly relieved competition that previously boxed out purchasers in that segment.

Borrowers with the Federal Housing Administration-insured loans now sometimes have a chance to put in an offer unopposed rather than contending with 10 to 15 other offers as they would have last year, Mortgage Bankers Association Chief Economist Mike Fratantoni said.

"The real estate agent may be a little more interested in the FHA bid," Fratantoni told attendees at a Mortgage Industry Standards Maintenance Organization meeting on Tuesday.

The reduced competition may account for a small pickup in FHA volume recorded in the MBA's most recent report on loan application activity, Fratantoni said. The FHA share of applications during the week ended Aug. 19 rose by half a percentage point to 12.5% from 12% as purchase activity drove the association's Government Index rose by 2.7% on a seasonally adjusted basis.

Some FHA borrowers have experienced frustration because buyers with conventional loans, cash offers or financing structured to serve as an equivalent have beat them out. Although cash-offer financing can convert to traditional mortgages, FHA loans don't allow it.

"The sellers have not been accepting FHA contracts, but I just was at a meeting recently where the Realtors were saying sellers are now starting to put that into the mix," said Mary Ann Cronin, a mortgage loan officer working for a division of Fulton Bank in Maryland.

To get a sense of how tough it's been for those who only qualify for FHA loans, Cronin recounted the experience of a borrower who looked for over a year, putting offers on at least 40 homes before finding and buying a property distressed enough to cut competition.

"It's just based on where the market was. It's starting to come back. The pendulum is starting to swing and is a little bit in the middle again, but we're not quite there yet," she said.

To be sure, the slight uptick in the MBA's application index last week could prove to be an aberration, particularly given that other reports have suggested that recent cooling has done less to relieve competition for entry-level homes than houses at the other end of the spectrum.

Aging baby boomers, for example, are leaving their homes and freeing up inventory, but that trend is not well-matched with entry-level market needs, said Fratantoni.

"They're trying to sell 5,000-square-foot homes and you have first-time homebuyers who say, 'No, thank you, unless you're going to discount tremendously,'" he said.

While FHA borrowers might be in a better position to get their bids accepted these days, with affordability still under strain, underwriting might continue to tighten, making it tougher to get mortgages. 

Although some lenders have relaxed underwriting to capture more loans when originations have fallen in the past, they've tightened recently. FHA products in particular tend to have higher delinquency rates and may get underwritten with caution. The second-quarter FHA seasonally adjusted delinquency rate was 8.85%, compared to 4.22% for loans that the Department of Veterans Affairs guaranteed and 2.64% conventional mortgages, according to the MBA.

Although the FHA number may seem high, it's been falling and delinquencies in general have remained historically low due to strong employment, Fratantoni noted. 

"Delinquency is extraordinarily low. We're in a great position," he said. "If we do get [a] recession and unemployment goes to 5.5%, [it] will go up, but we're going to be nowhere near the peaks that we've been at the last two cycles," he said. (FHA delinquencies neared 16% at their peak.)

The impact of student loan forgiveness

Helpful to the housing market in general, including first-time homebuyers, is student loan forgiveness of $10,000 to $20,000, which Barclays has estimated could on average generate $100 to $200 per month in savings for those eligible.

The forgiveness will have a quantifiable impact, with the savings equating to a 50 to 100 basis-point rate incentive for a typical conventional borrower, according to Barclays' agency mortgage-backed securities research.

The amount won't completely offset climbing home prices and a recent 250 basis-point increase in mortgage rate but it will mitigate it, Michael Khankin and Pratham Saxena, research analysts at Barclays, said in the report.

"An extra couple hundred bucks a month means you can either afford more home or you can afford maybe the same home at the higher interest rate, however you want to slice it," Khankin said.

That will likely boost housing affordability and home sales, but not until after the pandemic pause on student loans expires at the end of this year.

"It might influence people's decisions as soon as now, if you think that people are on top of this and are aware of it coming, but realistically I would think it would not have much impact until next year, and probably then it would take a couple of months," Khankin said.

Further lowering and aligning major housing agencies' qualifying ratios related to the amount of student debt carried would more immediately boost activity among first-time homebuyers with education loans, originators who work with them say. Since the FHA took one step toward this previously, some have begun hoping agencies might be willing to build on it more broadly.

Currently, agencies typically use 1% or 0.5% in a formula that comes into play when no typical monthly payment is reported due to a payment pause or ongoing schooling, and some believe lowering the amount to consistent 0.25% might safely expand the first-time buyer market 

"In my opinion, they should change it across the board to 0.25% to help a person with student loan debt for qualifying purposes," Cronin said.